The Benefits of Post-Money SAFE Over Pre-Money SAFE

An article we liked from Thought Leader DC Palter:

Why You Should Embrace the Post-Money SAFE and Avoid the Pre-Money SAFE

It’s the best vehicle for investing in early-stage startups

Last week I had the opportunity to speak about why I think the post-money SAFE is the best investment vehicle for early-stage start-ups, better than convertible notes.

While I was preparing my presentation, by some weird cosmic coincidence, I had not one but three startups pitch me on investing using the old pre-money SAFE that investors hate. It made my head explode.

I thought the old pre-money SAFE was dead and buried, but it seems to be making a comeback. Unfortunately, this resurgence is highlighting the horrors of the pre-money SAFE and eclipsing the greatness of the post-money SAFE.

Meanwhile, skittish investors are continuing to just say no to SAFEs without considering the critical difference between the two versions.

So I’d like to explain why investors should love the post-money SAFE and why startups should avoid the pre-money SAFE if they want to attract investors. The reasons are in the details, so if you don’t want the tl;dr, here’s the executive summary:

• Startups: The pre-money SAFE was deprecated in 2018 because investors hated it. We hate it even more now. It’s a non-starter. If you want investment, don’t use it.
• Investors: The pre-money SAFE sucked. It’s gone. The new post-money SAFE is better than convertible notes. Get over your instinctive dread of the SAFE and welcome the post-money SAFE as the best way to invest in startups.

Startup Investment Options

The options to invest in a startup are:

• Common stock
• Preferred stock
• Convertible note
• SAFE

Common stock is for founders and employees. For investors, they’re a non-starter. Investors require preferred shares with protections that prevent the founder from unilaterally wiping out our investment.

Preferred shares are ideal, but there’s a lot of terms and paperwork which takes time and money. Unless you’re raising at least $2M, preferred shares rarely make sense to issue.

For smaller raises, we need something lightweight. We need a placeholder that allows us to invest now and get preferred shares when they’re issued later.

There’s 2 choices: convertible notes and SAFEs. Though the goals are the same, they’re very different vehicles. Which one is used has huge implications for both the startups and investors.

Historically, investors have preferred convertible notes for their flexibility and protections. Startups and accelerators have preferred SAFEs for their simplicity.

Understanding the Convertible Note

The convertible note is legally a loan that includes an option to convert the principal and interest to preferred stock once it’s issued.

Because it’s a loan, the convertible note includes a maturity date, usually 18–24 months, along with an interest rate. The conversion option lists the agreed pre-money valuation and discount for the preferred shares.

The maturity date creates a deadline by which the startup has to raise a priced round of funding and issue the preferred shares. If the company reaches the maturity date without raising a priced round, whether the loan has to be repaid or it automatically converts to preferred shares is just one of the critical details that has to be negotiated between the startup and lead investor.

While far simpler than preferred equity, considerable time and cost is still required to negotiate the terms of the convertible note.

For investors, there’s another important consideration. As a debt investment, convertible notes don’t qualify for the incredible Sections 1202 and 1244 tax breaks for investing in startups until the debt is converted into equity.

Convertible notes add an extra 18–24 months to the 5 years we have to hold equity before qualifying for tax-free gains. And if the company fails before reaching the next round, we don’t get the benefit of writing off our losses against income instead of capital gains.

More importantly, convertible notes almost always use a...

Read the rest of this article at entrepreneurshandbook.co...

Thanks for this article excerpt to DC Palter. DC is a serial tech entrepreneur, active angel investor, and startup mentor. His weekly articles about early-stage pitching and fundraising are read by thousands of founders. He is also the author of the Silicon Valley mystery novel, To Kill a Unicorn, about a startup that claims to have developed disruptive technology and the hacker trying to find out if they’re a real estate scam or something far more sinister.

Photo by Cytonn Photography on Unsplash

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